Matt Ridenour, Managing Director at of Momentum Venture Management
Back in the late 1990s, getting venture funding wasn't a matter of if, but of how much. After all, in a climate where unproven Internet companies run by 25-year-olds were going public on a regular basis, VC firms were backing just about any business with a name ending in "dot-com." By 2002, however, the climate was markedly different as many of the darlings of the so-called new economy were out of business. Five years after the collapse of the sector, however, venture capitalists are still investing in the technology sector. It's just that the rules have changed.
For starters, VC firms have moved "up market," meaning that true series A funding is less likely. Here's why: as a rule of thumb, VCs need to invest between 5% and 10% of their fund in any given deal, so if they have $200 million under management, they'll be looking for 10-15 deals where they can invest around $15 million each. For companies looking for smaller amounts - say $1 million to $5 million - the major venture backers probably aren't a good fit.
Angel investors have traditionally been a reliable source of money for companies looking for smaller rounds, but the fall of the dot-coms fundamentally changed how these individuals evaluate prospective portfolio companies. In response to the tech-sector meltdown, they have adopted more stringent standards to gauge whether or not they will back a particular firm. Instead of basing their decisions on a sales pitch and a handshake, many of today's angel investors have upped their requirements, including requiring companies to demonstrate that they already have working business models in place. In addition, individual investors have banded together to form groups such as Tech Coast Angels, which provide collective analysis and recommendations about whether to back a particular venture. In essence, angels have taken the place of early-stage VC firms and have significantly raised the bar for who gets funding.
In a perfect world, investment dollars would automatically find their way to the most innovative companies with the best ideas. The reality today, however, is far from ideal. With the dot-com meltdown still fresh in people's minds, investors are basing their funding decisions on more than the ebullience of a CEO claiming to have the Next Big Thing. One of the hallmarks of today's culture of cautiousness is that venture capital firms and angel investors want to see a viable company - not just a promising concept - before they write a check. The good news is that early-stage technology entrepreneurs can make the right moves to put themselves in a position to raise capital, even before they start the process of looking for outside investment. But even though the investment climate is far different than it was seven or eight years ago, savvy companies looking for an infusion of capital can still get backing - if they follow this roadmap:
1. Realistic "self assessment". The first step is to understand and be honest about where you and your company is in the funding "ecosystem," which ranges from home equity to family to friends to individual angels to angel groups to VCs. Generally, you can sell vision and excitement to people who know you but you'll need a complete plan, team, technology and paying customers to market to angel groups and VCs.
2. Understand the target investor: Entrepreneurs really understand their customer but don't spend any time researching and understanding their "target" investor. When it comes to institutional investors (affiliated angels or VCs) if you don't fit their particular profile you are wasting your time (and theirs) by approaching them. What industry do they invest in? Have they already invested in a competitor? What size investment do they like to make? Which partner in the firm is most likely to be interested in your story?
3. Manage the process with the right materials. There is a right way and a wrong way to approach an investor. Remember, your ONLY job in any given interaction is to get to the next step. You don't have to tell the investor everything in the first meeting - you only have to tell them what is necessary to get to the next step. Telling them a lot more than this (or in the wrong format) takes a risk that the important messages get lost, or worse, they disagree with some aspect of your message that wasn't that important.
4. Field the best team possible. Investors spend a lot of time poring over data, but they ultimately make decisions based on their gut feelings about whether or not a team can “pull it off”. That is why so many teams that have “been there and done that” tend to get funded over and over again. Companies that have experienced, skilled senior-level executives with "name-brand" job experience and academic degrees have an inherent advantage when it comes to lining up the funding you need to grow your business. If your company is too early-stage to attract these kinds of full-time executives, you should seek to attract mentors that will actively serve on an advisory board or turn to groups that will go at risk in an interim executive role.
The reality is that the chances are very slim that an individual start-up will ever achieve backing by an angel group or a VC. On the other hand, a company that has assembled all the right ingredients has a much higher likelihood of raising these funds. Savvy entrepreneurs need to devote as much time and effort to understanding and managing the fundraising process as they do to building their businesses.
Matt Ridenour is Managing Director of Momentum Venture Management, a Los Angeles-based firm that helps early-stage companies achieve early business results and develop credibility in order to get funding and transform their ideas, technologies and products into sustainable, successful businesses. For more information, please visit www.mvmpartners.com.